Finance Leasing Manual - FLM21.27

'Capital element' in lessors rentals: avoidance of tax

The Schedule 12 FA 1997 Part I 'interest-into-capital' schemes (see FLM28.01 onwards) were able to avoid tax on both the 'interest' and the 'capital' elements in the lessor's rentals. Schedule 12, Parts I and II sought to deal with the worst cases and should have prevented avoidance of the 'interest' element. But Schedule 12 does not deal with schemes where the finance lessor gets the 'capital' element in the form of an actual capital sum. For example, by selling the asset, or an asset representing the asset, for an actual capital sum. This could be done either as part of a pre-planned scheme or simply as an unplanned decision part way through the lease.

Consider an extreme example. Suppose a lessee wants to borrow £10 million for ten years. The lessee sells an asset to a finance lessor for £10 million. The finance lessor leases the asset back for 20 years. For the first ten years the rentals payable are just enough to pay the 'interest' accruing each year. At the end of the tenth year the lessee has an option to acquire an asset representing the original asset for £10 million. If the option isn't exercised the rentals for the second ten years rise so that they both pay off the 'interest' and the 'capital'. On a conventional view of the existing law, the £10 million option price is a pure capital sum. But Part I Schedule 12 FA 1997 does not apply because the capital sum is not a 'major lump sum' (see FLM31.38). This is because it contains no 'interest' element which is outside the charge on income. Nor is there a capital allowances recovery because the asset itself is not sold and so ordinary balancing adjustments cannot be made.

If you see such schemes please let BTD4 Leasing know.